Federal grants under the Smart Grid Investment Grant program will not be taxed, the Treasury and Energy Department announced on Wednesday.

This means that the Internal revenue Service will provide a safe harbor for corporations receiving grants under the $3.4 billion federal stimulus program, which funds projects that aid the modernization of the energy grid.

Smart Grid capabilities would update a system that is facing stress with the nation's increasing energy needs and cut down on energy waste through the use of sophisticated meters and sensors that monitor and control electrical consumption.

"By clarifying the tax treatment of Smart Grid Investment Grants, we are ensuring that their full impact is felt in the communities where these investments are being made," Treasury Assistant Secretary for Management Dan Tangherlini said.

But there's no such thing as a free ride. According to the fine print, "Section 362(c)(2) of the Code requires a basis reduction in a corporation's property when the corporation receives money from a nonshareholder as a contribution to its capital."

In other words, corporations have to reduce the tax basis of their property as a condition for receiving these tax breaks.

"The result is a reduction in tax benefits such as depreciation over the life of the property and higher taxable gain (or reduced losses) on its eventual disposition," explained attorney James Atkinson, who was also previously Associate Chief Counsel for income tax and accounting at the IRS.

The intended incentive may be blunted, and the news is not as favorable as perhaps many in the industry had hoped, he said.

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